The world would have been simpler, though less interesting, if workers in Detroit and Beijing earned the same wage, cost of making a shirt was the same in Boston and Dhaka, and everyone paid the same tax. But it isn't and never was. Cost of stitching a garment in Bangladesh is — and will continue to be for a long time — less expensive, just as writing software is cheaper in India.

The world's first MNC, The East India Company, and later the rich nations of Europe, had discovered how profitable it was to produce something where the cost was lower and ship it to buyers who were ready to pay many times more. For centuries, this was the rule of the game.

When new-age MNCs began spreading their wings, the world was changing: financial markets turned more sophisticated, means of transportation and communication improved dramatically, new accounting systems evolved and modern tax havens were born. A global company could raise cheap money, use it to put up factories where the manufacturing cost was lowest, sell the produce in markets that fetched the best price and park the earnings in a jurisdiction where it had to pay the least tax. For these corporations with global balancesheets, the whole world was their playfield.

But somewhere along the way, there were murmurs that it wasn't a fair game. An MNC's earnings from selling products made by its arms in Latin America and Asia were not booked in those regions and, thus, no tax was paid to countries that housed the factories. The Leftist economists dubbed it as neo-colonialism while sensible minds in the high-table of rich nations felt there should be checks and balances; that there should be new rules, not just to give a better deal to less developed countries functioning as cheap production centres but also to curb tax evasion. Taxmen went about framing the new code.

They began questioning cross-border transactions carried out between a company and its associates at prices that appear unrealistic; prices that were not at "arm's length". An Indian arm selling a product to the US parent at a dirt-cheap rate — may be at the cost price or a little above it — came under glare. The local company, according to Indian tax authorities, is simply not charging its US firm the real market price it would have charged any other buyer that was unrelated to it. For the taxman, it's a mechanism to transfer profit across the border to escape tax in India. So, what does the taxman do? He finds out the actual price in the market to figure out the profit margin of other companies selling similar products. To the taxman, this is the profit that an Indian affiliate of the US firm should have booked in India, but has chosen not to. Therefore, it should be taxed.

So, an Indian arm of an MNC that issued shares at.`10 apiece is faced with a huge tax demand. The company has argued that it only raised capital by issuing new shares and had not earned any income by selling existing equity. The taxman has countered that if the shares were sold to any other financial or strategic investor and not to the parent, the Indian arm would have charged a hefty premium; then, why were the shares sold cheap? Did the Indian firm give away benefits? The government and lawmakers may choose to explore the point in the coming days, even make a case to change the law to cover deals that may not necessarily generate 'income'. But going by the strict definition and the language of the law on taxation of transactions — that are better known as transfer pricing (TP) practices — it may be difficult for tax officials to stretch their interpretation, even if they take refuge in other provisions of the law as it reads today.

In the complex world of taxation, TP is an imperfect science; an element of subjectivity always creeps in. MNC parents say tax offices ignore socioeconomic complexities. They argue that a transaction price factors in risks and liabilities an MNC parent has to take on behalf of subsidiaries; also, profit margins can be way below what the tax office calculation is in a downturn when the priority is not making money but staying afloat. In India, the available data can be misleading. In arriving at tax demands, the department has to stick to standard databases of listed companies in the public domain that often don't convey the complete picture.

But the tax office, pushed to collect more tax, has stepped into a minefield. After the Vodafone fiasco, the business community in general, and MNCs in particular, have complained that India's tax regime is unpredictable, even hostile. The present tax demands on TP deals, a comparatively new territory, will add to the noise. This, however, should not alarm serious investors who are familiar with TP disputes worldwide. But, while the taxman may not always bark up the wrong tree on TP, he has to pick the right data and make pragmatic assumptions. Wrong arithmetic and impractical postulates will defeat his case and fuel confusion.